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Risk analysis on Islamic banks 代写

    Risk analysis on Islamic banks

     Risk analysis on Islamic banks   代写
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     

    Executive summary

    Islamic banking and finance, in its current form, is a relatively new industry. Its current asset base of one trillion USD is experiencing annual growth of 15-20 percent. It is categorized by being interest free and depends largely on the principles of Islamic Law (Shari’ah). The Islamic financial system is based on real economic activity, the bank and its customer’s relationship is cooperation, joint venture relationship, to a certain extent, this relationship inspired each party's enthusiasm. The article gives the background information of Islamic banks at first, and then literature review on Islamic banking is given. The article followed by risks analyzed and possible risk diminishment measurements. At last conclusions and recommendations are given.
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
    Table contents
    Executive summary. 1
    Background of Islamic banking. 1
    Literature review and methodology. 2
    Risks the Islamic banks might expose to. 3
    How can they diminish these risks?. 4
    Conclusions and recommendations. 5
    References. 6
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     

    Background of Islamic banking

    Islamic banks have to obey the Sharia regulations strictly during their daily operations, and their financial transactions and operations should be conducted according to the codes established by Sharia scholars. As implemented in daily operations, there are some activities that are restricted: prohibiting interest charging, prohibiting speculation and prohibiting gambling. The Islamic banking industry has developed so fast in recent years. According to Mckinsey (2007) research, there are more than 500 Islamic banks established all over the world since 1970s, and their assets have been grown at the rate of 15-20% annually, which makes them be the fastest growing banks as shown in figure 1. As the well-known 2008 financial crisis have swept the global banks, Islamic banks were able to maintain a stable growing in profit due to their safety investment approaches. There are 0.13-0.18 billion Muslims around the world, which account 15-20% of the total people. So the research of Islamic banks should be attractive both in study field and investment field.  

     (Sources: Persian management &consulting firm’s research report)
    In financial sense, Muslims conducts are confined to several codes: firstly, Muslims advocate not hoarding for speculation and usury. Speculations are seen as immoral conducts in Muslims world. Secondly, Sharia encourages people to exchange goods at equal values; and thirdly, Muslims believes the well being of lives is acquired by diligent work. These basic principles prohibit Muslims charge interests during financial transactions. Based on these codes, there are six principles applied for Islamic banking industry.
    The most fundamental principle of Islamic finance is prohibiting interest charge. In Sharia, the word for interest is “Riba”, which means residual value. The certain returns confirmed in advance are redeemed as exploitation to clients. Comparably, Muslim codes encourage profit which is generated after, as earning profit is seen as the symbol of enterprising. The second principle is that the capital only has contingent value. Muslims believe that cash only gains its value when invested in real producing activities. They disagree the concept of risk free returns. Thirdly, because of interest prohibiting, Muslims put forward the thoughts of risk sharing in banks operation. The banks and their clients are operation partners. Fourthly, Muslims redeemed contractions as divine obligations. They emphasized the information release, even private information. Fifthly, Islamic banks set up Shariah Board or Shariah Advisory Council in the administrative structure. The board is composed of at least 3 experienced bankers who expertise of sharia regulations and highly independent. They are in charge of the financial instruments being complied with the Sharia regulations. And at last, the Islamic banks are prohibited from the speculation activities and providing services to alcoholic, gambling and pork industry.  

    Literature review and methodology

    Risk analysis on Islamic banks   代写
    The research on Islamic banks has been getting hotter and hotter in recent years. Islamic countries and international organizations have summoned kinds of seminars to discuss and absorb financial theories to guide the operations of Islamic banks. Ausaf Ahmad (2000) studied the possible monetary policies and monetary tools to supervise Islamic banks in Islam financial systems. And he studied whether the traditional managing approaches are effective or not during the process of applying them on Islamic banking industry by comparing two cases. Osman Babikir Ahand (2001) studied the current financial products among Islamic banks, and he pointed that these products have brought the short term liquidity problems to Islamic banks. The author pointed out that a new product innovation should be designed in order to improve the liquidity and comply with the Islamic banking operations. Salman Syed Ali (2005) based on samples of Bahrain, Malaysia, Pakistan and Sudan, studied the securities market and pointed out the possible problems during their development. Dahia El-Hawary, Wafik Grais and Aamir Iqbla (2006) studied the supervising diversity of Islamic financial institutions (IFIs) and concluded that the supervising methods differ from each other of different countries. An international organizations should be set up in order to coordinates and harmonize the supervisions. And they have analyzed possible risks faced by Islamic banks and brought up possible supervising models.  
    And studies focusing on risk management of Islamic banks are conducted by Kham (1997), Voge and Hayes (1998), Obaidullah and Wilson (1999), Karim (1999), Khan and Ahmad (2003). They pointed out that possible risks confronted by Islamic banks are not only confined to traditional risks exposed to general banks, and Islamic banks have to indentify specific risks exposed due to their unique capital structure. Khan and Ahmad (2003) believed that these new risks are attributed to Sharia regulations that Islamic banks have to obey during the banks’ operations. Besides, Hassan in his article pointed that risks exposed by Islamic banks are different to general banks. Ljaz Ahmed Samdani (2007) diversified risks based on Islamic terms “Ghanar”, which means uncertainty. According to Sharia regulations, Ghanar makes contractions          
    Invalid. He classified Ghanar as the uncertainty of subject matter, uncertainty of delivery, uncertainty of maturity and the ambiguousness of contraction itself. There are two kinds of risks suffered by Islamic banks: internal risk and external risk. External risks are aroused by changes on policies and basis like Libor. Internal risks involve default risk of debtors, operation risk, etc.   

    Risks the Islamic banks might expose to

    Risk analysis on Islamic banks   代写
    In one sense, if there is no risk, the society may be passive. Islamic banking is a relatively new industry, which makes them not understand totally of their risks. Possible risks exposed to Islamic banks would be analyzed in this part.
    1. Liquidity risk. According to Maroun (2002), the vulnerable weakness of Islamic banks is liquidity risk. There are two resources of Islamic banks’ capital: one is cash deposit account, and the other is bonus account. As the cash does not generate any profit, it can be seen as the debt to banks. Once the clients asked, payments should be implemented immediately. Islamic banks should keep some extent of liquid assets in case of deposit withdrawing at any time. Besides, the central bank requires 25% deposit reserves. And the bonus account also follows the withdrawing requirement at any time. Possible reasons for withdrawing are listed as below: (a) the real returns is below the expected returns; (b) rumors on banks financial stability; (c) transactions disobey the Sharia regulation. The slow development of Islamic instruments has refined the financing ability of these banks. The financial institutions lack of communications.  
    2. Price/commodity risks. One of the rare characteristics of Islamic banks management is that the bank bonds the financial contractions and the real assets together. This operation may cause the price risk, which is attributed to the possible price fall, deprecation or assets loss. And the commodity risk may be involved in the Salam contractions, because the future prices may be fluctuate.
    3. Credit risk. Islamic banks engage in the profit share investment business. The banks’ revenue is directly related to the clients’ profit. If the clients operated badly or their operations lack of transparency, the banks could suffer losses. These factors make the banks confront great credit risks. Besides, Islamic banks would not choose to punish their clients if they delay the repayments or sue them, which make the banks have few choices in the front of default risks.
    4. Exchange risk. Most of the Islamic banks choose US dollar as their basic currency. The fluctuation of the dollar value makes the bank expose in the exchange risk. Islamic banks are not allowed to operate foreign exchange future or options, or to purchase the future contracts. Similar to the traditional banks, when Islamic banks facing the international agent banks who deal with more kinds of currencies, they suffer greater exchange risk.
    5. Law risk. Law risk is significant in Islamic banks’ operations. The Sharia supervision committee requires the contract should be effective with the Sharia regulation; however, these conditions may be against with the local laws or regulations. When operating in the non-Islamic countries, the law risk exposes. 
    Similar to traditional banks, Islamic banks also suffer risks like operation risk, technology risk, system risk, etc.

    How can they diminish these risks?

    There are five technologies to diminish the risks applied by Islamic banks.
    (1) Risk prevention. If risks can be prevented without loss, then such risks should be prevented; (2) risk adaptation. If the financial instruments comply with Muslim doctrines, there are no restrictions in an equal market. In Islamic code, subsidiary collateral and the third party guarantee are allowed; (3). Risks avoid. If one investment suffers high risks, Sharia regulations would reject the investment no matter how much revenue it could be. Islamic supervision board would evaluate and measure the risks before investing decisions are made; (4) risk reduction. Complying with Muslim doctrines, banks can invest on different categories or companies. (5) Risk transfer. Islamic banks could transfer risks by hedging. 
    Specific to kinds of risks, the Islamic banks have set up reports to records the liquid assets and managing systems to decrease the liquid risks as much as possible. For price risk, Islamic banks could sign the other Salam contractions to avoid it. And for exchange risk, the banks could try to diversify the basic currencies. For law risk, the bank could hire lawyers to harmonize the possible problems. Now the article would like to introduce some detailed measures Islamic banks have implemented to diminish the risks.  
    1. Credit risk. In order to diminish the credit risk, Islamic banks should set up a pool which records the clients default risk and investigate the clients’ payment ability. Although fees are forbidden when the clients are unable to fulfill their responsibility, the banks could punish the clients when it is proven that they are able and unwilling to pay. And the other way to diminish the credit risk is guarantee requirement. As mentioned above, both the profit and loss should be shared by the banks. Under Mudarabah case, if the banks are only the capital provider and not involve in the management, then the Islamic banks should indentify clearly their partners’ credit records and the investment. And in order to diminish credit risk, Islamic banks could establish a default risk management department responsible for (1) periodically communicate with the clients and investigate the operations; (2) collect credit and other financial data of clients; (3) charge the punishment fees when a client disobeys the Sharia codes and unwilling to pay; (4) reorganize the debt when the clients are unable to pay; (5) deal with the collateral and other guarantee affairs when the clients have high debt level.
    2. Exchanging risk. Under the restrictions of Sharia codes, Islamic banks use the hedging methods which are allowed to diminish the risks brought by the fluctuation of exchange. Assume that AFH is obligated to pay 2 million dollars in three months, and the current exchange rate is LBP1500/US dollar. Here exchange risk exposed if US dollar appreciated in the future. Under such cases, the Islamic banks could sign a contract with its debtors and set up a share account. The bank would buy the US dollars at the spot rate at 2 million values and save the dollar in three month. When the debt goes to maturity, the bank could share the loss or profit with the debt no matter US dollar account generate profit or suffer loss. Here possible hedging is applied to diminish the exchange risk.   

    Conclusions and recommendations

    The article chooses Islamic banks as the research object. Firstly, the article gave a brief introduction to the Islamic banks. Based on that, the article reviewed possible literatures and researches on the Islamic banks. And then, the article analyzed the possible risks existed of Islamic banks. Besides the common risks to general banks, liquidity risk, price risk, law risk, exchange risk, etc are unique to Islamic banks due to their specific operational environment. At then, the article discussed possible ways to diminish the risks. Two specific risks are given as the example to show how the Islamic banks diminish the risks they face. They are credit risk and exchange risk. Based on the analysis above, the article give some recommendations as follow:
    the risks exposed to Islamic banks are specific and unique. Due to the restrictions of Sharia codes, Islamic banks have to deal with some specific operations compared to other general banks. These restrictions and operations have exposed the Islamic banks to some unique risks. Such risks should be studied and treated differently. The risk diminishing measures should combine the existed theories and the unique environment and restrictions, so financial innovation are encouraged.
     
     
     Risk analysis on Islamic banks   代写

    References

    McKinsey (2007). World Islamic Banking Competitiveness report
    Amr Mohamed El Tiby Ahmed (2000). Instruments of Regulation and Control of Islamic Banks by the Central Banks. Islamic Research and Training Institute
    OsmanvBabikirbAhmed (2001). Islamic Financial Instruments to Manage Short-term Excess Liquidity. Islamic Research and Training Institute
    Salmān Saiyid ʿAlī (2005). Islamic capital Market Products: Development and Challenges. Islamic Research and Training Institute
    Zamir Iqbal, Abbas Mirakhor, Hossein Askari (2006). Diversity in the Regulation of Islamic Financial Institutions. The Quarterly Review of Economics and Finance
    Amr Mohamed El Tiby Ahmed (2003). Risk Management in Islamic Banks. IRTI publication
    Salman Ahmed Shaikh (2007). Islamic Banking and Ghanar. Karachi: Idara-e-Islamiat
    Monzer Kahf (2005), BaselⅡ: Implications for Islamic Banking’ Paper written for the 6th international Conference on Islamic Economics and Banking, Jakarta :22~24
    Maroon Harpoon (2002). Liquidity Management and Trade Financing in Islamic Finance Growth and Innovations: 163~175